NORWOOD FINANCIAL CORP

Net income for the Company for the year ended December 31, 2023 was $16,759,000, which was $12,474,000 lower than the $29,233,000 earned in the year ended December 31, 2022. Earnings per share on a fully diluted basis were $2.07 for 2023 compared to $3.58 in 2022. The return on average assets for the year ended December 31, 2023, was 0.79%, and the return on average equity was 9.67%, compared to 1.43% and 16.11%, respectively, for the year ended December 31, 2022. Net interest income decreased $6,330,000 for the year ended December 31, 2023. The decrease in net income for the year ended December 31, 2023, is primarily attributable to a $4,648,000 increase in the provision for credit losses, a $1,808,000 decrease in other income, and a $2,453,000 increase in other expenses.

For the year ended December 31, 2023, fully taxable equivalent (“fte”) net interest income totaled $62,816,000, a decrease of $6,348,000 from the year ended December 31, 2022 total. Average loans outstanding increased $164.7 million in 2023, which contributed to an increase in interest income (fte) of $19.2 million. During the year ended December 31, 2023, average interest-bearing deposits decreased $441,000. During the year ended December 31, 2023, however, total interest expense increased $19.6 million due increased market interest rates. The cost of borrowed funds increased $6.6 million in 2023, compared to the prior year due to an increase in borrowings, and higher market interest rates. During the year ended December 31, 2023, the resulting net interest spread (fte) decreased to 2.47% compared to 3.38% at December 31, 2022, as a 0.78% increase in the yield earned was offset by a 1.69% increase in the cost of funds.

Total other income for the year ended December 31, 2023 was $8,124,000, compared to $9,932,000 in the prior year, a decrease of $1,808,000. During the year ended December 31, 2023, gains on the sale of loans and investment securities decreased $152,000 in the aggregate, while gains on the sale of foreclosed real estate owned decreased $347,000. Earnings and proceeds on life insurance policies decreased $75,000 in 2023 compared to 2022, while all other items of other income decreased $1,234,000, net, in 2023. The decrease in 2023 includes $1.1 million of earnings recognized in 2022 due to the payoff of purchased impaired loans acquired at a discount.

During the year ended December 31 ,2023, other expenses were $43,497,000, compared to $41,044,000 for the same period in 2022, an increase of $2,453,000. Salaries and benefits costs increased $1,494,000 in 2023, while data processing costs increased $394,000. Taxes, other than income decreased $447,000. All other operating expenses increased $1,012,000, net, in 2023. Income tax expense for the 2023 year totaled $4,387,000, which was a decrease of $2,765,000 from the 2022 year ended. The effective tax rate in 2023 was 20.7% compared to 19.7% in 2022.

The following table sets forth changes in net income (in thousands):

NET INTEREST INCOME

Net interest income is the most significant source of revenue for the Company and represented 88.4% of total revenue for the year ended December 31, 2023. Net interest income (fte) totaled $62,816,000 for the year ended December 31, 2023 compared to $69,164,000 for 2022, an decrease of $6,348,000. The resulting fte net interest spread and net interest margin were 2.47% and 3.06%, respectively, in 2023 compared to 3.38% and 3.53%, respectively, in 2022.

Interest income (fte) for the year ended December 31, 2023 totaled $96,289,00 compared to $76,433,000 in 2022. The fte yield on average earning assetswas 4.68%, increasing 78 basis points from the 3.90% reported last year. The tax-equivalent yield on total loans was 5.46% in 2023, increasing from 4.73% in 2022, while average loans outstanding increased $164.7 million, resulting in an increase in interest income (fte) from loans of $19.2 million. The yield on securities increased 17 basis points in 2023 due primarily to higher yields on new securities purchased during the year ended December 31, 2023. During the year ended December 31, 2023, while average securities outstanding decreased $1.4 million, interest income (fte) from securities outstanding, increased $803,000 from the year ended December 31, 2022.

Interest expense was $33,473,000 for the year ended December 31, 2023, which resulted in an average cost of interest-bearing liabilities of 2.21% compared to total interest expense of $7,269,000 during the year ended December 31, 2022, with an average cost of 0.52%. Total interest-bearing deposits cost was 1.96% for the year ended December 31, 2023, which was an increase of 147 basis points over the 2022 fiscal year ended. The increase in cost was due primarily to time certificates of deposit that repriced to current market rates upon maturity, resulting in an increase in the interest rate paid from 0.97% in 2022 to 3.25% in 2023. Borrowing costs also increased in 2023, reflecting the higher market interest rate environment.

PROVISION FOR CREDIT LOSSES

The provision for credit losses was $5,548,000 in 2023 compared to $900,000 in 2022. During the twelve month period ended December 31, 2023, the Bank recognized a charge-off in the amount of $4,806,000 on one commercial credit relationship resulting from the borrower’s inability to make scheduled contractual payments. This isolated event contributed to an increase in net charge-offs for the twelve months ended December 31, 2023 to $6,078,000 from the $343,000 of net charge-offs reported for the twelve months ended December 31, 2022. As of December 31, 2023, the remaining carrying value of the credit was $4,150,000, which was classified as a nonaccrual loan.

The Company makes provisions for, or releases of, credit losses in an amount necessary to maintain the allowance for credit losses at an acceptable level under the current expected credit loss methodology analysis.

OTHER INCOME

Total other income was $8,124,000 for the year ended December 31, 2023, compared to $9,932,000 in 2022, a decrease of $1,808,000. Debit card fees decreased $194,000 in 2023, loan related service fees decreased $222,000, and gains on the sale of foreclosed real estate owned decreased $347,000. During 2023, gains on the sale of loans and investment securities decreased $152,000 in the aggregate, while all other items of other income decreased $893,000, net, due primarily to $1.1 million of income recognized in 2022 on previously acquired purchased impaired loans that were carried at a discount.

Other Income (dollars in thousands)

For the year ended December 31

OTHER EXPENSES

Other expenses totaled $43,497,000 for the year ended December 31, 2023, compared to $41,044,000 in the 2022 fiscal year. Salaries and employee benefits costs increased $1,494,000 in 2023, while data processing costs increased $394,000. FDIC insurance assessments increased $373,000. During the year ended December 31, 2023, all other operating expenses increased $192,000, net. The Company’s efficiency ratio, which measures total other expenses as a percentage of net interest income (fte) plus other income, was 61.3% in 2023 compared to 51.9% in 2022.

Other Expenses (dollars in thousands)

For the year ended December 31

INCOME TAXES

Income tax expense for the year ended December 31, 2023 totaled $4,387,000, which resulted in an effective tax rate of 20.7%, compared to $7,152,000 and 19.7% for 2022.

CAPITAL AND DIVIDENDS

Total stockholders’ equity as of December 31, 2023, was $181.1 million, compared to $167.1 million as of December 31, 2022. Earnings retention, net of a $9.5 million reduction resulting from cash dividends declared, contributed to the increase. Fluctuations in interest rates during the year ended December 31, 2023, impacted the fair value of the Company’s Available-for-Sale securities, and contributed to $10.0 million increase in accumulated other comprehensive income. As of December 31, 2023 the Company had a leverage capital ratio of 9.00%, a Tier 1 risk-based capital ratio and a common equity Tier 1 risk-based capital ratio of 11.99%, and a total risk-based capital ratio of 13.06%, compared to 9.36%, 12.49% and 13.58%, respectively, at December 31, 2022.

NON-GAAP FINANCIAL MEASURES

This Annual Report contains or references fully taxable-equivalent interest income and net interest income, which are non-GAAP financial measures. Tax-equivalent interest income and net interest income are derived from GAAP interest income and net interest income using a marginal tax rate of 21%. We believe the presentation of interest income and net interest income on a fully taxable-equivalent basis ensures comparability of interest income and net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice.

Thefollowing table reconciles net interest income to net interest income on a fully taxable-equivalent basis:

CONSOLIDATED AVERAGE BALANCE SHEETS WITH RESULTANT INTEREST AND RATES

(Tax-Equivalent Basis, dollars in thousands)

(1)Interest and yields are presented on a tax-equivalent basis using a marginal tax rate of 21%.

(2)Average balances have been calculated based on daily balances.

(3)Loan balances include non-accrual loans and are net of unearned income.

(4)Loan yields include the effect of amortization of purchased credit marks and deferred fees net of costs.

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RATE/VOLUME ANALYSIS

The following table shows the fully taxable equivalent effect of changes in volumes and rates on interest income and interest expense.

Changes in net interest income that could not be specifically identified as either a rate or volume change were allocated proportionately to changes in volume and changes in rate.